February 14, 2020

U.S. Consumer Spending Preview: Q4 2019

by Jharonne Martis.

The coronavirus crisis in China has added new concerns for U.S. retailers. First, it was the tariff war, now it’s the infectious disease that has affected tens of thousands, prolonged store closures in China and affected retailers’ revenue.

The outbreak has put pressure on China’s officials to demonstrate greater transparency towards the public and international organizations such as the World Health Organization. As a result, Wall Street has been skeptical about the accuracy of China’s economic and GDP data. Because of this doubt, we dig deeper to gain a better insight into true economic activity. We also turn to macro research data from Fathom Consulting, which can be found in Eikon Datastream.

They have built the China Momentum Indicator (CMI) proprietary index which combines 12 measures of economic activity, including retail sales, unoccupied housing and net trade. According to the CMI, China’s economy continues to slow down more drastically that the Chinese government has lead to believe. Now with the coronavirus outbreak, this is becoming a big drag on the economy (Exhibit 1). The outbreak affected the stock market, retailers, the gaming industry in Macau and tourism. Many retailers have closed down manufacturing in China, affecting exports to the U.S. and earnings guidance for the upcoming quarter.

Exhibit 1: Fathom China Momentum Indicator: 2016 – 2020

Source: I/B/E/S data from Refinitiv

Q4 2019 earnings and revenue guidance

Since the beginning of the fourth quarter, retailers discussed China tariffs in 112 earnings calls. On the other hand, retailers started discussing the coronavirus two weeks ago. By the end of January, only four retailers had discussed it. Now, discussions of the coronavirus have taken place in 28 earnings calls and that might not be the end of it.

The bulk of retailers say that it is very challenging to quantify the damage cause by the outbreak. The Chinese consumer accounts for a big portion of luxury retail sales and one of the first retailers to discuss the coronavirus was LVMH. The retailer said that it is hard to predict how long the outbreak will last and its direct effects on revenue. They also said if the outbreak lasts a couple of months and is resolved within 2 1/2 months then it won’t be all that bad. However, if it lasts two years it would be a different matter.

As a result, retailers are also warning us not to expect much from them in the upcoming quarters. Retailers are getting ready to report Q4 earnings and have been actively discussing the coronavirus issue over the past two weeks. To date, there have been nine negative EPS pre-announcements for Q1 2020 compared to three positive preannouncements.

Exhibit 2: The Refinitiv Retail Earnings/Revenue Guidance – Q4 2019 and Q1 2020

Source: I/B/E/S data from Refinitiv

Likewise, when looking at revenue, there are more negative than positive pre-announcements. About 30% of this negative guidance is coming from footwear, including Nike, which said last week that in the short term, they expect the situation to have a material impact on its operations in greater China.

But what about the long-term? As retailers keep releasing negative guidance and announce numerous store closings, Wall Street is wondering: which retailers might be better set up for the long haul?

Sustainable leadership monitor

To analyze the long-term orientation of Nike, we turn to Eikon’s Sustainable Leadership Monitor (SLM), a data-driven app that uniquely aggregates a deep range of financial fundamentals with environmental, social and governance (ESG) criteria. This will allow us to compare Nike against peer performance to analyze long-term goals vs. a benchmark. Looking at the SLM dashboard, three out of the four pillars show strong scores of 77 and higher – thus placing it in the top quartile scores for environment, long-term returns and citizenship pillars.

The blue line in the middle of the circle is the benchmark median (Exhibit 3). And thus, when we focus on the long-term return for Nike, it is evident that it is much stronger than its peers in this area.

Digging deeper into the data, Nike’s earnings quality score is 88, suggesting that earnings are coming from sustainable sources. It’s sitting on a solid amount of cash and operating efficiency looks great. The other significant component here is the StarMine Combined Credit Risk model. This model systematically calculates the default probability (DP%) within the next 12 months for all companies by region with a score of 1 having the highest probability of default. Nike however, scores a 95 out of a possible 100, thus suggesting a very low probability of default. However, the longer the coronavirus outbreak persists, the worse the financial health of companies with exposure to China may get.

Nike’s weakest pillar score is the governance principle, which looks at the retailer’s management, shareholders and corporate social responsibility (CSR) strategy to ensure shareholders are voting on key topics, while avoiding personal interests. Nike does not shy away from ads that make social statements and have been known to spark controversy. Additionally, when it comes to financial matters, the company has also been involved in business ethics controversies and as a result it scores a 1 on this principle.

Still, because of its strong financial position compared to its peers, these high long-term scores suggest that profits are coming from sustainable sources. The company’s cash flow and operating efficiency also look healthy, thus giving the company some cushion during the slowdown in China.

What’s more, Nike outperforms its peers in the various SLM pillars, implying that it is best positioned among its peers to weather the coronavirus effects on its market.

Exhibit 3: Sustainable Leadership Monitor for Nike

Source: Refinitiv ESG data

Q4 2019 earnings

The Refinitiv U.S. Retail and Restaurant Q4 earnings index is expected to rise 3.0%. When looking at the earnings growth rates for Q4 for the 208 retailers tracked by Refinitiv, the textiles, apparel and luxury goods sector has the highest earnings growth rate at 14.7% (Exhibit 4). On the flip side, multiline Internet and catalog retail has the weakest anticipated Q4 2019 growth estimate of -9.3%.

In the textiles, apparel and luxury goods sector, footwear retailers are bringing the sector up with Crocs Inc.’s 104.4% estimated growth rate, while Nike already posted a 34.6% earnings growth rate. Meanwhile, Movado Group Inc. (-68.7%) has the weakest EPS growth estimate in the sector. Fourteen of the 21 companies in this group have positive earnings growth rates.

The multiline retail earnings growth rate is being affected by negative earnings growth expectations. Seven of the 10 companies in this group have negative earnings growth rates. The department stores are expected to post weaker earnings vs. last year and are bringing the sector down. JCP earnings are expected to see the biggest decline, followed by Macy’s and Kohl’s with a -136.0%, -28.3% and -16.1% estimated earnings growth rates.

Exhibit 4: The Refinitiv Retail Earnings Growth Rate – Q4 2019

Source: I/B/E/S data from Refinitiv

Retail sales

Retailers are facing very tough comparisons from a year ago, when consumer spending was robust and the sector posted strong same store sales (SSS) in Q4 2018. The Refinitiv SSS index is expected to see 2.4% growth in Q4 2019. A 3.0% SSS reflects healthy consumer spending. The 2.4% SSS estimate is below the 4.1% result seen in Q4 2018.

Exhibit 5: Refinitiv Same Store Sales Index: 2017 – Present

Source: I/B/E/S data from Refinitiv

Sector slowdown

The two sectors in retail that continue to see a slowdown in spending are the department and apparel groups (Exhibit 6), resulting in deteriorating same store sales from last year. For Q4 2019, the department group is expected to post a -0.4% SSS, considerably below its 0.7% SSS result last year. And, the same can be said for the apparel group, which is expected to post a 1.2% SSS for Q4 2019, below last year’s 3.7% SSS result.

Exhibit 6: Refinitiv Same Store Sales Weakest Indices: 2018 – Present

Source: I/B/E/S data from Refinitiv

Pier One has already missed its -4.0% SSS estimate and posted a -11.4% Q4 2019 SSS result. Likewise, Bed Bath & Beyond registered a -8.3% SSS, missing its -5.0% SSS estimate. Despite increased promotions, these retailers experienced weak store traffic and now have inventory management issues. JC Penney continues to have the weakest SSS estimate among the department stores at -7.3% (Exhibit 7) and is haunted by severe debt. The department store has the lowest score of 1 on the StarMine Combined Credit Risk Model, the most comprehensive StarMine credit model. According to StarMine, there’s a high probability of credit default. Meanwhile, mall stores have been out of favor and continue to experience weak store traffic. These stores include Gamestop, Kirkland’s, J. Jill, Gap and Limited Brands, with comp estimates of -26.5%, -8.5%, -7.0%, -3.8% and -2.7%, respectively.

Exhibit 7: Refinitiv Weakest Same Store Sales Estimates: Q4 2019

Source: I/B/E/S data from Refinitiv

Sector improvement

Consumer spending was strong in 2018, and as a result all retail sectors are facing difficult Q4 2019 comparisons from a year-ago. Despite this, home improvement continues to show robust results, and is expected to post an impressive 4.4% Q4 2019 SSS, above last year’s 2.6% SSS result (Exhibit 8).

Exhibit 8: Refinitiv Strongest SSS Sector – Home Improvement: 2018 – Present

Source: I/B/E/S data from Refinitiv

The Lovesac company, dubbed the “world’s most adaptable couch,” has the strongest SSS estimate in our retail universe with a 34.7% SSS comp. In apparel, Lululemon is on top, benefiting from the hot athleisure trend, with a 16.2% SSS estimate. Meanwhile, consumers are buying apparel at Zumiez and Aritzia. The latter already beat its 4.3% SSS estimate with a 5.1% SSS result, despite facing an impressive 12.9% Q4 2018 SSS result. Meanwhile, Costco is on top among the discounters and already reported a 4.3% result, slightly below its 4.4% SSS estimate.

Exhibit 9: Refinitiv Strongest Same Store Sales Estimates: Q4 2019

 

Source: I/B/E/S data from Refinitiv Favorite Retailers

For a more organic view of which companies are connecting emotionally with their customer base, we turn to MarketPsych Indices from Refinitiv. They scour the news and other media constantly, analyze it and extract meaning.

Below is a ranked list displaying equities with the highest average sentiment scores over the past decade according to the MarketPsych Indices. These are the most loved stores in our Refinitiv Same Store Sales Index since 2010.  The results underline the importance of the value proposition to consumers. TJX, CHS and ROST were the top loved stocks over the past decade, showing that shoppers love the deals there.

Exhibit 10: The Most Loved Retailers: 2010 – Present

Source: MarketPsych app in Eikon

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